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conflicting results

Shyamal Paul

a

, Rabindra N. Bhattacharya

b,

*

a

Khalisani Mahavidyalaya, Chandannagar-712138, W. B., India

b

Department of Economics, Kalyani University-741235, W. B., India

Available online 25 September 2004

Abstract

This note examines the different direction of causal relation between energy consumption and

economic growth in India. Applying EngleGranger cointegration approach combined with the

standard Granger causality test on Indian data for the period 19501996, we find that bi-directional

causality exists between energy consumption and economic growth. Further, we apply Johansen

multivariate cointegration technique on the different set of variables. The same direction of causality

exists between energy consumption and economic growth. This is different from the results obtained

in earlier studies.

D 2004 Elsevier B.V. All rights reserved.

JEL classification: Q

41

; Q

43

Keywords: Energy consumption; Economic growth; India; Granger causality; Cointegration

1. Introduction

All production and many consumption activities involve energy as an essential input. It

is the key source of economic growth, industrialization and urbanization. On the other

hand, economic growth, industrialization and urbanization may induce use of more energy,

0140-9883/$ - see front matter D 2004 Elsevier B.V. All rights reserved.

doi:10.1016/j.eneco.2004.07.002

* Corresponding author. Tel.: +91 33 2582 8750x288/289; fax: +91 33 2582 8282.

E-mail addresses: shyeco@yahoo.co.in (S. Paul)8 rnbeco@yahoo.com (R.N. Bhattacharya).

Energy Economics 26 (2004) 977983

www.elsevier.com/locate/eneco

particularly commercial energy. India has been passing through an economic reform since

1991, the general aim of which is to quadruple its economic growth and remove the

problems of poverty and unemployment. One of the obstacles to achieve these objectives

has been the frequent occurrence of energy shortages in the economy. In India, commercial

energy consumption over time has grown at a compound annual growth rate (CAGR) of

about 6% which is more than the CAGR of GDP during the last two decades.

1

So the

relation between energy consumption and economic growth is of great interest to the

energy economists. It is not possible to achieve high growth in one, without keeping pace

with another.

The direction of causation between energy consumption and economic growth has

significant implications. If, for example, there exists unidirectional causality running

from economic growth to energy consumption, it may be implied that energy

conservation policies may be implemented with little adverse or no effects on

economic growth. On the other hand, if unidirectional causality runs from energy

consumption to income, reducing energy consumption could lead to fall in income.

The finding of no causality in either direction, the so-called dneutrality hypothesisT

would imply that energy conservation policies do not affect economic growth (Asafu-

Adjaye, 2000).

However, in India not much attention has been devoted to investigate the causal

relationship between economic growth and energy consumption. In some earlier studies

Pachuri (1977) and Tyner (1978) using regression approach have found a strong relation

between energy consumption and economic growth in India. Cheng (1999) in his quest for

causality has established a unidirectional causal relation from economic growth to energy

consumption. In contrast, Asafu-Adjaye (2000) has estimated a unidirectional Granger

causality from energy consumption to income. The finding of Asafu-Adjaye (2000) does

not support the finding of Cheng (1999). Our empirical result identifies bi-directional

causality between energy consumption and economic growth. The present analysis

attempts to discuss how our finding contrasts with the findings of Cheng (1999) and

Asafu-Adjaye (2000).

2. Empirical evidence

The empirical findings on the causal issue between energy consumption and economic

growth have been mixed or conflicting. The reason for the disparate and often conflicting

empirical findings lies in the variety of approaches of time frame considered and testing

procedures employed in the analysis.

Cheng (1999) has applied JohansenHsiaos version of the Granger causality

method on the Indian data for the time period 19521995. This study finds that energy

consumption, economic growth, capital and labour are cointegrated and the direction of

causality runs from economic growth to energy consumption both in the short-run and

1

It is worthwhile to note that past trend in energy consumption does not fully represent the growth of energy

demand. To a large extent it reflects the net availability (Bhattacharya and Paul, 2001).

S. Paul, R.N. Bhattacharya / Energy Economics 26 (2004) 977983 978

in the long run. No causal relation is found from energy consumption to economic

growth.

The modeling strategy adopted in Asafu-Adjaye (2000) is based on the Engle and

Granger (1987) methodology. He used three variablescommercial energy use, real

income and energy prices proxied by the consumer price index for the period 1973

1995 and found unidirectional Granger causality running from energy consumption to

economic growth both in the short run and in the long run. This discrepancy in results

between Cheng (1999) and Asafu-Adjaye (2000) may be due either to the choice of the

sample period or to the measure of the variables or to the choice of the methodology or

to both.

Now, based on our exercise, let us indicate the result of causality between energy

consumption and economic growth in India using a sample of annual data covering

the period 19501996. If a linear combination of the non-stationary variables is non-

stationary, then the Standard Granger causality test should be adopted. If a linear

combination of the non-stationary is stationary, then error-correction model (ECM)

should be adopted. We adopt the standard Grangers causality test (1969) when GDP

is treated as a dependent variable and then the error-correction model when energy

is considered as a dependent variable. Our combined results of the standard Granger

causality test and the EngleGranger error correction approach imply bi-directional

causal relation between energy consumption and economic growth. The Johansen

multivariate approach (1991) at lag length 3 reveals that the long-run causality exists

from economic growth to energy consumption and the short-run causality runs

from energy consumption to economic growth.

2

That is, a bi-directional causality

exists between energy consumption and economic growth (results are shown in

Appendix A).

The results of the standard Granger test and the EngleGranger approach show only

unidirectional causality between energy consumption and economic growth. But the

direction of causality in the approaches is different. In the EngleGranger model, the

long-run causality runs from economic growth to energy consumption and in the

standard Granger model, the causality runs from energy consumption to economic

growth. Use of Johansen multivariate approach reveals a short-run causality from energy

consumption to economic growth and the long-run causality from economic growth to

energy consumption. The interpretation of this short-run and long-run divergence in

causal relation between energy consumption and economic growth can be given as

follows.

In the short-run, energy, particularly commercial energy acts as an engine of economic

growth. It is a very important primary input in the aggregate production function. In the

context of a less developed country like India, the substitution of non-commercial energy

by commercial energy is likely to be limited in the short-run. But in the long run, with the

growth of income and technological progress, it is likely that more and more non-

commercial energy will be substituted by commercial energy.

2

The appropriate selection of lag will generate white noise residual process. Small lag misspecifies the model

and large lag indicates that the degrees of freedom are wasted (Hamilton, 1994).

S. Paul, R.N. Bhattacharya / Energy Economics 26 (2004) 977983 979

3. Discussion and conclusions

This note has demonstrated that the causal relation between energy consumption

and economic growth in India is mixed or conflicting. The results obtained from one

approach are found to be different from another. Our empirical results using the

standard Granger causality test reveal a unidirectional causal relation from energy

consumption to economic growth. This process does not show any causal effect from

economic growth to energy consumption. However, use of EngleGranger cointegra-

tion process exhibits a unidirectional long-run causality from GDP along with capital

to energy consumption. No short-run relation is found. The results of the Engle

Granger approach combined with the standard Granger causality process indicate that

there is bi-directional causality between energy consumption and economic growth.

The long-run causal relation runs from GDP to energy consumption and the short-run

causal relation runs from energy consumption to GDP. The same results are obtained

by using Johansen multivariate approach on the different combination of variables.

These results are at variance with the results obtained by Cheng (1999) and Asafu-

Adjaye (2000).

Acknowledgements

We are grateful to an anonymous Associate Editor of this journal for some helpful

comments on an earlier draft of this paper. However, usual disclaimer applies.

Appendix A

In the following tables variables used are named as E=commercial energy

consumption, G=national income of the Indian economy, F=gross fixed capital formation

of the economy and L=population, a proxy for labour. All variables are expressed in terms

of natural logarithm.

Table 1

Cointegration tests (EngleGranger procedure)

Regression equation:

Y

t

X

1t

X

2t

a b c q (statistics) n

G

t

C

t

F

t

6.08 0.45 0.38 0.35 (2.86) 1

E

t

G

t

F

t

7.50 0.69 0.43 0.53* (4.04) 1

F

t

E

t

G

t

0.21 0.53 0.62 0.61* (5.50) 1

(a) Absolute t-statistics are in the parentheses. The 5% critical value for the t-statistic is 3.79 for 50

observations; see Charemza and Deadman (1999), Table 2.

(b) The parameter n was chosen in such a way that there was no serial correlation in the residuals in Engle and

Granger (1987) two-step procedure of cointegration test.

(c) * denotes statistically significant.

S. Paul, R.N. Bhattacharya / Energy Economics 26 (2004) 977983 980

Table 3

Test statistics of temporal causality using ECM based on cointegrating regression of EngleGranger procedure

Controlled

variable

1st manipulated

variable

2nd manipulated

variable

FPE F-value Error-correction

(Ec

t 1

)

1st Regression equation

E(i=1) 2.100329103

E(i=1) F( j=1) G(m=1) 2.162463403 0.82

E(i=1) F( j=1) G(m=1) 2.234479603 0.48 0.36* (3.11)

2nd Regression equation

F(i=4) 1.569449103

F(i=4) G( j=1) E(m=1) 1.647142803 0.44

F(i=4) G( j=1) E(m=1) 1.728100003 0.08 0.55* (3.86)

(a) The figures in parentheses behind the variables are the optimal lag length. Other figures in parentheses are the

absolute t-statistics.

(b) * denotes statistically significant.

Table 4

Johansen ML Procedure

Null Alternative Statistics 95% Critical value

r=0 r=1 27.33 22.00

rV2 r=2 13.90 15.67

rV3 r=3 6.49 9.23

Cointegration LR test Statistics: three variables VAR.

I(1) Variables included: E, G, F; Lag ( P)=3.

(a) r denotes the number of cointegrating vectors.

(b) Statistics on the above table based on the Maximal Eigen value of the Stochastic matrix.

Table 2

Granger standard causality test

Controlled

variable

1st manipulated

variable

2nd manipulated

variable

FPE F-value

Economic growth equation

G(i=1) 6.05904904

G(i=1) E( j=2) 5.40954304 4.77 *

G(i=1) E( j=2) F(m=1) 5.66098404 0.31

Energy consumption equation

E(i=1) 2.56107403

E(i=1) G( j=1) 2.65269803 0.39

E(i=1) G( j=1) F(m=1) 2.74081303 0.002

(a) The figures in parentheses behind the variables are the optimal lag length. Other figures in parentheses are the

absolute t-statistics.

(b) * denotes statistically significant.

S. Paul, R.N. Bhattacharya / Energy Economics 26 (2004) 977983 981

Table 6

Vector Error-Correction (VEC) model

Equation no. Dependent

variable

Independent variable ( F-statistics) Error-correction term (t-statistics)

DE

t i

DG

tj

DF

tm

Ec

t

1 DE

t

... 0.31 (0.74) 1.65 (0.21) 3.28* (0.00)

2 DG

t

4.75* (0.02) ... 1.03 (0.37) 0.01 (0.19)

(a) P-values are in the parentheses.

b) * denotes statistically significant.

Table 7

Johansen ML Procedure

Null Alternative Statistics 95% Critical value

r=0 r=1 33.02 28.14

rV2 r=2 19.16 22.00

rV3 r=3 9.39 15.67

rV4 r=4 5.23 9.24

Cointegration LR test Statistics: four variables VAR.

I(1) Variables included: E, G, F, L; Lag ( P)=3.

(a) r denotes the number of cointegrating vectors.

(b) Statistics on the above table based on the Maximal Eigen value of the Stochastic matrix.

Table 8

Johansen ML Procedure

Null Alternative Statistics 95% Critical value

r=0 r=1 66.79 53.12

rV2 r=2 33.78 34.91

rV3 r=3 14.62 19.96

rV4 r=4 5.23 9.24

Cointegration LR test Statistics: four variables VAR.

I(1) Variables included: E, G, F, L; Lag ( P)=3.

(a) r denotes the number of cointegrating vectors.

(b) Statistics on the above table based on the Trace of the Stochastic matrix.

Table 5

Johansen ML Procedure

Null Alternative Statistics 95% Critical value

r=0 r=1 47.72 34.91

rV2 r=2 20.39 19.96

rV3 r=3 6.49 9.23

Cointegration LR test Statistics: three variables VAR.

I(1) Variables included: E, G, F; Lag ( P)=3.

(a) r denotes the number of cointegrating vectors.

(b) Statistics on the above table based on the Trace of the Stochastic matrix.

S. Paul, R.N. Bhattacharya / Energy Economics 26 (2004) 977983 982

References

Asafu-Adjaye, J., 2000. The relationship between energy consumption, energy prices and economic growth: time

series evidence from Asian developing countries. Energy Economics 22, 615625.

Bhattacharya, R.N., Paul, S., 2001. Sectoral changes in consumption and intensity of energy in India. Indian

Economic Review xxxvi (2), 381392.

Charemza, W.W., Deadman, D.F., 1999. New Directions in Econometric Practice. Edward Elger Publishing, UK.

Cheng, B.S., 1999. Causality between energy consumption and economic growth in India: an application of

cointegration and error-correction modeling. Indian Economic Review xxxiv (1), 3949.

Engle, R.F., Granger, C.W.J., 1987. Cointegration and error correction: representation, estimation and testing.

Econometrica 55, 251276.

Granger, C.W.J., 1969. Investigating causal relations by econometric and cross-spectral methods. Econometrica

37, 424438.

Hamilton, J.D., 1994. Time Series Analysis. Princeton University Press, Princeton, NJ.

Johansen, S., 1991. Estimation and hypothesis testing of cointegration vector in Gaussian vector autoregressive

models. Econometrica 59, 15511580.

Pachuri, R.K., 1977. Energy and Economic Development in India. Praeger Publishers, New York.

Tyner, W.A., 1978. Energy Resources and Economic Development in India. Boston, Martines Nijhoff Social

Sciences Division, Netherlands.

Table 9

Vector Error-Correction (VEC) model

Equation

no.

Dependent

variable

Independent variable ( F-statistics) Error-correction term (t-statistics)

DE

ti

DG

tj

DF

tm

DL

tn

Ec

t

1 DE

t

... 1.19 (0.32) 0.67 (0.52) 0.61 (0.55) 2.80* (0.00)

2 DG

t

4.50* (0.02) ... 1.14 (0.33) 0.21 (0.81) 1.35 (0.19)

(a) P-values are in the parentheses.

(b) * denotes statistically significant.

S. Paul, R.N. Bhattacharya / Energy Economics 26 (2004) 977983 983

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